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Consumer Bankruptcy and Financial Health

Here is an article published in March 2015 on the website fivethirtyeight reviewing a recent study by the National Bureau of Economic Research which shows that bankruptcy can help to greatly improve a person’s credit score and improve his chances of becoming a homeowner.

What they found: Filing for bankruptcy protection helps financially struggling borrowers hold onto their assets and raise their credit scores and makes them more likely to own their homes.

Why It Matters

Chapters 7 and 13 of the U.S. bankruptcy code allows individuals to reduce their debts while retaining their assets. In theory, bankruptcy is meant to give borrowers a chance to get back on their feet while giving lenders a chance to recoup at least part of what they’re owed. But measuring the impact of bankruptcy on borrowers is difficult because, by definition, people who file for bankruptcy are in financial trouble; even in a best-case scenario, they’re likely to end up worse off than people who never got into trouble in the first place. In this paper, the authors take advantage of the fact that bankruptcy cases are assigned to judges at random. Since some judges are more lenient than others, the authors are able to study the impact of bankruptcy protection on people who are in similar financial circumstances. They find that in the five years after a bankruptcy filing, people who are granted protection have a 13.2 percentage point greater probability of being homeowners and have a 14.9-point higher credit score, on average, than those not allowed to enter bankruptcy. The amount of debt they have in collection fell by $1,315 on average.